PREPARING FOR AN UNCERTAIN ECONOMY

They’re neither the “best of.” nor the “worst of times these days but managers must be vigilant and prepared for certain small curves that events may occasionally throw at them.

“It was the best of times, it was the worst of times, we had everything before us, we had nothing before us.” Charles Dickens’ famous opening sentence in his 1859 novel A Tale of Two Cities also serves as an appropriate introduction to a commentary on today’s economy. I cannot remember a time when business conditions looked so immediately good but executives were so worried. For many executives, it comes down to a single question: “If things are so good, why do I feel so bad?” Perhaps executive suites need more psychiatrists and fewer economists.

The apparent schizophrenia is justified. It is a time for cautious optimism — hoping and being ready for the best but bracing and preparing for the worst; relentlessly planning; managing and controlling the risk agenda; focusing on the core principles of running a good business.

Economic forecasting is rich in one liners: “Economists forecast to make astrologers look respectable”; “Economists provide a number or a date but never both”; “Economists are never wrong, just early or late,” and “Economists have correctly called nine of the last four recessions.”

But behind the comedy and the cynicism, economic forecasting is actually based on some pretty good science in the form of econometric models that use multipliers and coefficients based on long data periods to quantify relationships and project key economic variables. The news from the models is not bad for executives. For openers, nothing approaching catastrophe is on the horizon. That may not seem like much but given the “end is nigh” commentary that is so prevalent, it should not be discounted.

In terms of the numbers, if the future is at least an approximate average of past cause/effect relationships, look for real growth to be in the quite respectable three percent area, with job growth holding its own and inflation and the current account remaining satisfactory. Every industry is different but three percent sustained real growth with tame inflation is a rather nice macroeconomic environment in which to profitably grow a competitive business. It is certainly an environment that should leave executives feeling a lot better than they do.

The litany of things that have executives on edge about the economy is lengthy. First, about 40 percent of our economy is based on exports and close to 90 percent of those exports are to the United States. That makes U.S. exports over 35 percent of our economy, which is fine when the U.S. thrives. But when the U.S. struggles, it is quite another story. The U.S. economy continues to barrel along but executives increasingly wonder how long it will continue to do so.

A particular concern is U.S. consumers. Carrying unprecedented personal and household debt, up to their ears in consumer goods and saving just about nothing, U.S. consumers may not be far from seriously dialling the spending back. As U.S. consumers go, so goes the U.S. economy and by extension, ours too.

It would not take much of a drop in U.S. consumer demand to send quite a chill through Canada; the effects here are greatly magnified.

Second, at six percent of GDP, the U .S. current account deficit is in unprecedented territory. That means the difference between what the U.S. buys from foreigners and sells to foreigners is six percent of U.S. GDP — a textbook case of a country living beyond its means. Even more to the point, it also means the U.S. must attract six percent of its GDP in foreign capital every year – an incredible two billion dollars every business day. Executives wonder how long the U.S. can be such a drain on world capital markets before U.S. interest rates start to meaningfully rise in the process, taking ours with them. Rising interest rates have a nasty history of slowing down economies.

Third, the potential upward pressure of the U.S. current account on interest rates aside, executives wonder how long interest rates can remain in record low territory in the face of growing pressures on inflation from high oil prices, a lengthy period of excessively easy monetary conditions and a huge U.S. federal spending deficit. Disengaging from low interest rates is likely to be far less fun than introducing them.

Fourth, a graph of the world economy since the 1960s shows four discernible declines: 1973, 1979, 1989 and 2000. Each is associated with a sharp rise in oil prices. The cause/effect relationships are both complex and changing but it is fairly safe to say that stable and reasonable oil prices are a necessary condition for a sustained good economy. Oil is up substantially over the last two years. If this persists, executives know sooner or later that the economy will tumble, probably sooner rather than later. That we have handsome oil reserves in Canada mitigates our exposure to oil prices somewhat. but we are not even close to being in the clear.

Fifth, housing and housing-related expenditures have been a key driver of our economy for the past two years. Executives wonder how long that can last. Rising interest rates always dampen the housing sector and then there is the question of just how much housing stock Canadians really need. Housing has a boom/bust aspect to it that can abruptly slow an economy when it turns.

Sixth, rising productivity is a must for a healthy economy in modern industrialized countries like Canada. Canada’s productivity relative to our major trading partner, the U.S., has been abysmal for a lengthly period of time. Executives worry that this is about to catch up with us. Productivity is closely linked to worker effort and investment. Both would benefit from a more friendly tax structure. Taxes are not the only issue in our productivity woes but they surely matter.

Finally, executives worry that we are due for a downturn. The business cycle is not dead. Economies go up and down and it has been quite a while since we have had the down part of the cycle.

Forecasting the economy, in the words of a great expression from the world of darts, is a “mug’s game.” You pay your money, you take your chances. If I had to guess today, I would say the economy through 2006 looks fine. I do not see serious slowdown, let alone decline. Personally, however, I do feel the heightened anxiety that executives feel. Things do not seem quite right and that speaks to risk on the downside. It screams “Be prudent.”

The economy will go where it will go. It is beyond executive control. What is not beyond executive control is how a business is run. Time spent worrying about the economy is not productive. What is productive is positioning a business to accommodate whatever the economy serves up.

Here are some suggestions for executives on what they can do to mitigate the exposure of their businesses to an untoward turn in the economy.

  • Monitor business conditions. Serious decline rarely comes right out of the blue. Now is the time for a heightened awareness of what is going on in the economy in general and the specific part of the economy that most affects your particular business.
  • Satisfying customers should always be first and foremost, but this becomes even more important as the economy slips. In a slowdown, competitors see your customers as a potential solution to their own business problems and become accordingly more aggressive. Executives should be brainstorming now on what they can do to assure ongoing customer loyalty. In the urge to grow, executives sometimes focus more on the customers they do not have than the ones they do. The folly of that strategy is exposed in spades when the economy goes south.
  • The businesses that most often fair the best in a deteriorating economy are the businesses with the best control of their costs. In a good economy, you can get away with careless spending. The chickens come home to roost when the economy turns. No business ever regretted being lean in a downturn. The time to get costs in order is before the economic news goes bad. The trouble is that controlling costs is one of the most difficult and least pleasant things an executive must do. Inevitably, it means saying no; usually it means letting people go.
  • Ready access to the funds needed to keep a business going can be the difference between a business surviving and not surviving a slowing economy. Now is the time to shore-up banking and other financial relationships that may provide needed capital. Of course, the better the balance sheet, the better the access to funds. Executives should be ensuring that their balance sheets are in order and their accounting conservative.
  • Weathering a bad economy can turn on the willingness of employees to go the extra mile. Strengthening the employer/employee relationship is always a good idea.
  • One of the reasons professional athletes practice so much is to prepare themselves to compete under pressure, when the mind can play tricks and take you out of your game. The business equivalent of practicing is planning. A bad economy greatly raises the stakes for executives. Good planning may provide something of an offset in that it can lead to more effective responses under pressure.
  • Revenues are the lifeblood of a business. They come from products sold to customers. A topnotch product line makes a downturn a lot easier to ride out. The product line should be a continual preoccupation of executives. It is with good reason that executives are apprehensive about the emerging economy. Hopefully, the apprehension will be misplaced. In the meantime, executives should do what they can to position for downturn. It certainly cannot hurt!